Sheppard Mullin Richter & Hampton LLP on 4/4/2012
author: Seth A. Mailhot]
As part of Sheppard Mullin’s monthly blog on tobacco retailer issues, we are taking a look at the possible future of retailer-operated rolling machines. On March 8, 2012, the U.S. Senate adopted an amendment to the federal highway bill “Moving Ahead for Progress in the 21st Century Act” (MAP–21) that included a provision impacting retail establishments that offer rolling machines for use to customers. The provision would have changed the definition of “manufacturer of tobacco products” in section 5702(d) of the Internal Revenue Code of 1986 to “include any person who for commercial purposes makes available for consumer use . . . a machine capable of making cigarettes, cigars, or other tobacco products.”
The bill containing the provision was never passed by the House. Instead, Congress voted on March 29 for another short-term extension of highway funds. This short-term extension lacked the provision changing the definition of a manufacturer of tobacco products. Regardless, retailers should be wary that this provision may reappear again in future legislation, transportation or otherwise.
The provision was offered by Senators Baucus, Murkowski, Bingaman, Crapo, Wyden, Risch, Merkley, Tester, and Bennet as part of an amendment to extend the Secure Rural Schools and Community Self-Determination Act of 2000 for one additional year. The amendment was adopted by the Senate in a vote of 82 to 16, demonstrating clear bipartisan support. There is no suggestion that the provision regarding rolling machines had any bearing on the overall fate of MAP-21.
Reports indicate that Congress views the change to the definition as an easy way to help balance costs associated with a bill or amendment. It is easy to see why. The provision was estimated to raise $99 million in Federal excise taxes. As noted in a recent article by The Washington Post, an aide to the Senate Finance Committee commented that a change to the definition has been considered by both the deficit-reduction supercommittee, and negotiators involved in the extension of the payroll tax cut. 
Congress is positioning the change to the definition as the closing of a “tax loophole,” and not a new tax. According to Senator Baucus, the provision:
. . . partially closes a loophole regarding roll-your-own tobacco. Congress raised taxes on tobacco to pay for the reauthorization of the Children’s Health Insurance Program in 2009. Tax rates on pipe tobacco were not increased as much as on roll-your-own tobacco; therefore, tobacco companies are selling bags of roll-your-own tobacco and labeling them as pipe tobacco. In other words, the pipe tobacco is masquerading as tobacco to be rolled into cigarettes to avoid the additional tax.
Senator Baucus noted that “[t]he abuse is so prevalent that gas station owners now have cigarette rolling machines to facilitate the loophole. A customer purchases a bag of pipe tobacco and then uses the machine to roll cigarettes.”
Despite the intent of Congress to close a perceived tax loophole created by the misuse of pipe tobacco, the provision (in its MAP-21 form) would also impact taxation of roll-your-own tobacco. As the provision only changes the definition of a “manufacturer of tobacco products,” it would draw no distinction between cigarettes rolled using pipe tobacco or roll-your-own tobacco. This could lead to the double taxation of roll-your-own tobacco.
Further, the language is vague enough to include retailers and companies that sell personal roll-your-own machines to consumers as “manufacturers of tobacco products.” Although section 5702(d) of the Internal Revenue Code currently includes an exemption for individuals that make tobacco products for their own personal consumption, this exemption would not apply to retailers and other companies that only sell supplies and equipment to individuals that make their own tobacco products.
Another issue not directly addressed in the language of the provision was how affected retailers would be treated under the Family Smoking Prevention and Tobacco Control Act (Tobacco Control Act). An expansion to the definition in the Internal Revenue Code would not have a direct bearing on the definition of a “tobacco product manufacturer” in the Tobacco Control Act. Despite this, the change to the Internal Revenue Code may prompt FDA to consider broadening its application of the current Tobacco Control Act definition to include rolling machine operations by retailers. If FDA decided to follow the lead of Congress (when and if such a provision is ultimately enacted), affected retailers would be subject to regulatory requirements equivalent to those imposed on cigarette manufacturers. Such regulatory requirements currently include payment of user fees, submitting premarket applications for new tobacco products, and compliance with labeling, good manufacturing practice (GMP), registration and reporting provisions.
If FDA chose to adopt a broader interpretation of “tobacco product manufacturer,” along the lines of the Internal Revenue Code proposal, it is not currently known how FDA would implement such a change. For example, FDA may determine such a change requires notice and comment through the traditional administrative rulemaking process. Alternatively, FDA may consider the current definition of “tobacco product manufacturer” in the Tobacco Control Act sufficiently broad enough to include retailers affected by the proposed Internal Revenue Code.
The Senate’s action last month leaves a number of unanswered questions that have a direct impact on the business of many retailers and other companies. Most immediate among these questions is the potential impact such a change would have on the taxation of retailers, and how the government might assess those taxes. Such a change would also undoubtedly have an impact on the taxes paid to states for the manufacture of cigarettes.
Sheppard Mullin is actively monitoring this provision, as it is an important issue for many retailers. Updates will be posted on our blog as they develop. Retailers and other companies seeking further clarity on this provision may contact the author directly.